Lenders in San Francisco’s struggling commercial real estate market are poised to default on billions of dollars in debt after the owners of the city’s largest mall and largest hotel stopped making loan payments and surrendered the keys to what was once the city’s most valuable property.
This week, Westfield and Brookfield Properties announced they had stopped payments on a $558 million loan secured by San Francisco’s sprawling downtown mall they’ve owned since 2002 and would turn the sites over to their lenders.
Days earlier, New York-listed Park Hotels & Resorts said it expected to hand over ownership of two of its main San Francisco hotels, the Hilton Union Square and Parc 55, after it stopped paying $725 million in loans. The hotels were worth more than $1.5 billion when the loans were issued in 2016, suggesting their owners believed their value had halved.
The massive default is the latest in a series of distress calls from landlords of San Francisco office buildings, hotels, apartment buildings and retailers. Since the coronavirus pandemic began, the city has grappled with a sharp drop in tourism and business travel, layoffs at tech companies, an exodus of residents and international scrutiny over crime, drug use and homelessness.
“San Francisco’s road to recovery remains clouded and lengthened by major challenges,” including “concerns about the state of the streets,” said Park Hotels CEO Thomas Baltimore.
The Westfield mall is half empty after brands such as Nordstrom left, partly because of “infested crime” and the fact that foot traffic in the city center has yet to recover after the pandemic. Westfield said its sales fell sharply between December 2019 and 2022, while sales at its other U.S. malls grew on average.
A default could trigger a fire sale of commercial real estate in the city, as lenders rush to sell assets at deep discounts to reduce risk and protect bondholders. In many cases, San Francisco’s large commercial real estate lenders, including JPMorgan, Deutsche Bank, Wells Fargo and Bank of America, syndicated real estate debt through commercial mortgage-backed securities. Economists say bondholders are likely to be hit as slumping property prices leave some loans in trouble – meaning assets are worth less than the loans are worth.
This repricing could have a knock-on effect, making it harder for homeowners to refinance debt as banks become more cautious about lending. Some U.S. banks have been reducing their exposure to the commercial real estate market following recent turmoil in the regional banking sector — the prospect of losses being particularly acute in San Francisco.
“We’ve reached an inflection point where we’re seeing a lot of (wider economic) headlines come to fruition in the San Francisco market,” said Lonnie Hendry, director of commercial real estate at data provider Trepp. Much faster elsewhere.”
Park Hotels & Resorts said it wants to hand over ownership of Hilton Union Square. . .
and Parc 55 Hotel © Justin Sullivan/Getty Images
In San Francisco’s financial district, some office buildings have changed hands in recent months for a quarter of what they were three years ago. WeWork defaulted on a $240 million loan on its 600 California Street building in April. Elsewhere downtown, Elon Musk’s Twitter stopped paying rent in November, forcing its landlords to default on a $400 million loan.
With the economic situation in San Francisco still uncertain, repricing could take longer. “Even if you can buy a building today for 50 cents relative to the loan balance, that doesn’t mean it’s a home run,” Hendry said. “We don’t know the floor yet.”
Wells Fargo has one of the largest exposures to commercial real estate in San Francisco, with about $34 billion in loans outstanding in California, filings show. The state accounts for the largest portion of its $155 billion total outstanding loans through the end of 2022 (the bank does not report data by city). Nearly $14 billion of Bank of America’s $73 billion in outstanding commercial real estate loans is in California. First Republic, which collapsed in May after a bank run and was acquired by JPMorgan Chase & Co., had about $12 billion of its $35 billion in commercial real estate loans originating in the San Francisco Bay Area, according to 2022 filings. The Westfield shopping center was financed in 2016, while the Park Hotels mortgage was serviced by Wells Fargo and initially underwritten by JP Morgan.
According to ratings agency Moody’s, 50% of CMBS office loans due in 2024 are at risk of default.
“In this case, the market has really lost faith in some assets, at least temporarily,” said Thomas LaSalvia, a senior economist at Moody’s. “It’s going to hit across the board,” he said of commercial real estate lenders. .
Just outside San Francisco in the wider Bay Area, tech giants including Google and Meta have sublet swaths of their offices. An executive at a firm that services defaulted CMBS loans says it creates an “uncomfortable position” for landlords and lenders with campus-backed loans. “If they don’t use the space, then it’s reasonable to assume they won’t renew the lease, so you have a big problem, but you can’t do anything until the lease is up,” the person said.
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The city faces the effects of a technology downturn and remote work, resulting in less demand for office space.
San Francisco’s office market will experience more distress than commercial real estate markets elsewhere, according to a senior executive at a large global real estate lender. He said there would be “refinancing challenges” as loans for vacant offices matured.
“Obviously, even if they put in more cash, the asset won’t be worth more than the debt balance, so (landlords will) ask themselves, would I be better off returning the asset to the lender?”
San Francisco’s office vacancy rate has risen to 30%, the highest of any major U.S. city. San Francisco hotels have also been hit particularly hard. The city’s average daily home price is $207, down from 2019 levels — one of only two large U.S. cities where home prices haven’t risen. Hotel bookings in San Francisco are vulnerable to a drop in Chinese tourists, and security concerns have prompted business meetings to relocate.
Club Quarters, a business hotel owned by Blackstone Group, has defaulted on $274 million in loans since 2020. The Huntington, a historic luxury hotel on Nob Hill, defaulted on a $56 million loan originated by Deutsche Bank last year and has since defaulted on it. Sold at a foreclosure auction for about half the loan amount.
More than 20 other hotel CMBS loans in San Francisco are due within the next two years, according to real estate data provider CoStar; 15 of them are on the lender’s “watch list,” meaning they’ve already missed repayments or may miss future ones. payment.
The rising number of defaults across multiple real estate asset classes has raised concerns that declining city tax revenues could fuel a “doom loop” — an economic and social spiral that cannot be reversed. Large office buildings trading at steep discounts would quickly eat into a significant portion of the city’s tax base. San Francisco is projected to run a $780 million budget deficit over the next two years, which will affect its ability to deliver public services or offer incentives to businesses to help revitalize downtown.
Owners of some of San Francisco’s iconic buildings, such as the Transamerica Pyramid and Uber’s Mission Bay headquarters, have petitioned the city to reduce their tax burden as property values plummet.
“The concern for San Francisco is that it has lost its critical mass,” said Moody’s LaSalvia. He said there was a “snowball effect” in which the departure of retailers and tech companies led to a further reduction in foot traffic, increasing the risk of remaining tenants and landlords, who were more likely to default.
“When you get below the point where the dynamism that attracts tourists, workers and shoppers goes away, it’s very difficult to come back,” he said.